What is an Eggshell Audit?
An eggshell audit is one in which the taxpayer has filed a fraudulent return in a prior year and the auditor is not aware of potential evidence of civil tax fraud or a criminal tax violation. A tax return is fraudulent if an additional tax is owed due to (i) a deliberate intent to evade tax or (ii) there is a willful and material submission of false statements/documents in connection with the return. It is considered an “eggshell” audit because of the care one must take – i.e. walk on eggshells – to guide the examination and prevent suspicion by the auditor.
What are the Risks of an Eggshell Audit?
A typical IRS audit may lead to a tax deficiency assessment whereby the taxpayer owes the underpaid tax plus interest and penalties. A deficiency is assessed when the underpayment was due to a mistake, inadvertence, reliance on incorrect technical advice, honest difference in opinion, negligence or carelessness. Because an eggshell audit includes a fraudulent tax return, an additional risk exists that the audit could lead to civil fraud penalties and the auditor may even refer the case to the IRS Criminal Investigation Division (CID) to pursue criminal tax fraud. If this eventually leads to the filing of criminal charges for tax evasion, your freedom may now be at stake.
What are the Differences Between Civil Tax Fraud and Criminal Tax Fraud?
Technically, the difference is the degree of proof required. Civil fraud cases require the government to prove fraud by clear and convincing evidence. Criminal tax fraud cases require the government to present sufficient evidence to prove guilt beyond a reasonable doubt. Clear and convincing evidence must prove that something is highly probable or reasonably certain, whereas evidence that is beyond a reasonable doubt can leave no doubt that would cause uncertainty in the mind of the person examining the evidence.
Civil fraud results in remedial action taken by the government such as assessing the correct tax and imposing fraud penalties such as fines. These civil fraud fines are generally greater than those associated with a tax deficiency and are owed in addition to the deficiency penalties. Furthermore, interest accrues on the penalty from the due date of the return. If convicted, criminal tax fraud includes the possibility of imprisonment in addition to the unpaid taxes, interest, and penalties. A tax fraud offense may result in both civil and criminal penalties.
What is the Role of a Tax Attorney in an Eggshell Audit?
An auditor is supposed to protect your rights as a taxpayer. However, an auditor is unlikely to inform you if the examination escalates from a civil examination to a criminal investigation. In fact, there can be an ongoing criminal investigation being carried out in conjunction to the audit and the auditor is collecting evidence for the criminal investigation. This is known as a “reverse eggshell audit”. Even if there is no concurrent criminal investigation, an auditor may nonetheless be conducting an examination with the objective of gathering evidence to establish proof of fraud without your knowledge. A tax attorney can intervene at any stage of the audit, ensure that the audit is conducted properly, and limit your future exposure.
Every U.S. citizen has a constitutional right against self-incrimination. An experienced tax lawyer will guide the examination in a way that protects that right while ensuring that any information provided to the auditor is truthful. This ensures that you don’t have to ever speak directly with any representative from the IRS.
A tax lawyer who specializes an IRS audit representation will navigate the taxpayer through the landmines of an eggshell audit. An audit can quickly (and unknowingly to the taxpayer) become a civil or criminal fraud investigation. This risk of additional penalties and imprisonment requires the expertise of a tax lawyer who can help mitigate such consequences. Even if the audit becomes a criminal fraud case, a tax attorney may be able to suppress evidence from the investigation if the taxpayer’s rights were violated.
An experienced tax attorney should provide vital assistance during the important time of preparation leading up to the audit. As a taxpayer facing an eggshell audit, you may have possession of documents that could, if disclosed to the IRS, potentially expose you to significant civil penalties or criminal prosecution. In order to prepare the best defense for you, a tax attorney will work with you to identify this information and make sure it is protected. Again, it is essential to partner with legal counsel on this matter, not your tax preparer, to ensure that the disclosures of sensitive information fall under the umbrella of the attorney-client privilege.
Eggshell audits are potentially dangerous matters for you and your business, as the ability to minimize the scope and context of the IRS’ investigation may mean the difference between a manageable civil penalty and criminal charges or fraud-related penalties.
What should you do?
Through the use of proper strategic planning, the eggshell audit may present an opportunity for the taxpayer to avoid potential criminal liability, and prevent an unpleasant situation from becoming exponentially worse.
Original Post By: Jeffrey Kahn